Planning for retirement has become a crucial task for people of all ages. Unlike prior generations, today's adults must be proactive in ensuring that they will have adequate financial support for both themselves and their families up until death.
In previous generations, retirees were able to rely on Social Security, pension plans—also known as defined benefit plans—and personal savings to provide financial support throughout retirement. Under a defined benefit plan, the monthly retirement benefit paid out is usually a definite amount based on a calculation that takes into account the retiree's years of employment, wages earned while employed, and his/her age. There is financial security in that a retiree is usually able to know the monthly pay-out of his/her retirement plan well in advance. Furthermore, retirees are guaranteed their defined benefit payment for the duration of their life.
However, in more recent years, most employers have stopped offering a defined benefits plan and converted to a defined contribution plan. In fact, at present only 20% of Americans work for a company that offers a defined benefits plan. Under a defined contribution plan, each participant in the plan has an individual account and is responsible for contributing money to the plan. This money is then invested and the value of the account either increases or decreases depending on market performance. The ultimate retirement benefit payment made during retirement is unknown at the time of contribution and is based on the performance of the account investments.
Because the retirement benefit payment is based on the value of the account, retirees are often overly cautious with their accounts during the contribution, investment and distribution period. A retiree may refuse to invest aggressively for fear that a down market will deplete their accounts and their retirement savings will be gone. Alternatively, even when a retiree's account has benefited from the market and increased greatly in value, a retiree may prefer to take minimal retirement benefit payments for fear of outliving the total funds. Thus, the problem with the defined contribution system is that it is largely based on conjecture and hope-conjecture in that a retiree attempts to guess how long he/she will live, and hope in that the retiree hopes that the funds in his/her defined contribution account will last until death. Often, the fear that a person will “outlive” their retirement account causes an over-cautiousness in terms of investment and distribution.
Between the defined contribution plan and Social Security, adults planning for retirement do not have an adequate means of developing a stable, certain and potentially long-standing financial base with which to live during the duration of their life.